Economics of Information Systems

Introduction

Making an investment decision is one of the most difficult exercises. Economists have to consider the fixed, variable, real, nominal and marginal costs associated with a project (Montgomery, 2002). The sunk costs and the opportunity costs are other set of costs that would somewhat influence the investment decision. The most important aspects to consider are the benefits associated with the project. To determine the viability of a project, economists have to carry out a stringent cost benefit analysis. If the costs associated with a project outweigh the potential benefits of the project, the project is unviable, and decision makers would consider the second best alternative (Kingma, 2001). However, if the project’s associated benefits outweigh the costs, the project is worth investing.

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In this case, we have an educational center that considers putting up an online system to learn French. This is a brilliant idea because the evolving world needs all-round persons with awareness of more than one language. Furthermore, the information system aims at employing the use of information technology, another very important aspect that would encourage IT literacy for all the stakeholders. The stakeholders will comprise of students, teachers, school staff.

The units of output are the number of stakeholders to learn or be involved in the online system to learn French at a particular time. The opportunity cost of putting up the online system to learn French is putting up a social and cultural facility for the educational center. This paper will discuss all the economic costs involved in putting up an online system to learn French and the associated benefits of the project in relation to the opportunity cost project. A stringent analysis and the benefit/cost ratios will determine if the project is worth implementing.

Economic costs of the project

Fixed costs

These costs are not proportional to the units of output (Mishan, 2008). In putting up an online system to learn French, the building and construction cost, the housing and utility costs, base infrastructure costs, computer hardware costs, operating system cost, software cost, maintenance cost and the peripheral infrastructure cost comprise of fixed costs (Thorsteinsson, 2010). Regardless of the number of units of output, the project must incur the costs. The table below shows the estimated fixed costs of putting up an online system to learn French as compared to the opportunity costs.

Type of fixed cost Cost of putting up an online system to learn French ($) Opportunity cost (cost of putting up a social and cultural centre) ($)
Building &construction 1000 1200
Housing &utility costs 800 1200
Base infrastructure costs 400 400
Computer hardware costs 1000 300
Operating system costs 200 80
Software costs 150 50
Maintenance costs 700 500
Peripheral infrastructure 500 1000
Total 4750 4730

Variable costs

These costs are directly proportional to the units of output (Varian, Farrell, & Shapiro, 2004). In putting up an online system to learn French, the water and electricity bills, WAN connectivity, insurance, wages and salaries comprise of the variable costs. The table below shows the estimated variable costs of putting up an online system to learn French as compared to the opportunity costs.

Type of variable cost Annual costs per unit output in putting up an online system to learn French ($) Annual costs per unit output for the opportunity cost (cost of putting up a social and cultural centre) ($)
Water & electricity bills 100 120
WAN connectivity costs 120 45
Insurance costs 105 50
Wages & salaries 270 80
Total 595 295

Sunk costs

These are costs incurred in the past and are irrecoverable whatsoever. Sunk costs are irrelevant in the decision making process as they have little or no impact on the investment decision (Ostrenga, 2005). The education center in discussion could have incurred costs out of outsourcing professionals to handle their French based tasks. They school could have sponsored its students, teachers or staff to go learn French somewhere else. These present sunk costs that are irrecoverable and irrelevant in the decision making process. However, they could somewhat stand as the motivating factor to putting up the online system to learn French.

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Real vs. nominal costs

The nominal value of a project is the value of the project in terms of money, while the real quantifies the value of the project in terms of another project or product (Juran & Gryna, 2003). In this case, the nominal value of putting up an online system to learn French is $4750 while the nominal value of putting up a social and cultural centre is $ 4730. In using the real values, we could say that the fixed cost of putting up an online system is about the fixed cost of putting up a social and cultural centre. Once again, we could say that the real annual cost per unit output for an online system to learn French is twice as much as the cost per unit output for putting up a social and cultural centre.

Marginal costs

This is the cost of producing one additional output (Lacity & Hirschheim, 2012). In this case, the marginal cost will be the cost incurred for accommodating one more stakeholder to learn the French language. An additional stakeholder (student, teacher, or school staff) would mean need for an additional tutor, additional insurance coverage, additional WAN connectivity and additional water and electricity bill. In this case, the annual marginal cost for learning the French language is $595, while the annual marginal cost for the opportunity cost (social and cultural services) is $ 295.

Economic benefits of the project

There are numerous benefits associated with putting up an online system to learn French. Quantifying the benefits in monetary terms would prove difficult but annual estimates of saved costs and generated benefits would act as the monetary economic benefits of the online system to learn French (Hubbard, 2010).

Benefits to the organization

  1. The organization will save an annual estimated cost of $1500; money spent on sponsoring students and instructors to learn French courses elsewhere.
  2. The organization will have annual estimated revenue of $4,500; monies collected from outsider students registering to learn French.
  3. The organization will have a higher rank in meeting the requirements set by the ministry of Education for an ideal educational centre. This benefit places the school at a better competitive advantage over the other learning institutions, an estimated annual advantage of $3,500.

Benefits to the students

  1. The students will have an added advantage of learning of a foreign language within the school syllabus. This would save each student an estimated annual amount of $200 that would be used to pay for French classes elsewhere.
  2. Students would be absorbed into the job market easily as compared to those who do not have knowledge of a foreign language. This would save students of hustling time; valuation of the time estimated to $100 per student.
  3. Students would be able to interact with the instructors freely. This would bring better understanding of things as compared to learning in a foreign land. This benefit enables students to obtain rich and quality information valued at $ 100 per student annually.

Benefits to the instructor

The instructors will have an easy time teaching the students who will have obtained skills from the online systems. This would save time that estimates to value about $1000 annually.

Cost benefit analysis

In determining if the project is worth installing, a cost benefit analysis is essential. In so doing, various assumptions are made to enable the cost benefit analysis.

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Assumptions

  1. Although fixed costs may change over time, assumptions are that fixed costs do not change over time in this case study.
  2. Although the variable costs per unit would change over time, assumptions are that variable costs are constant for the whole study period.
  3. The students presumed to be the only stakeholders to learn French, while the organization and the instructors will have an indirect benefit.
  4. The discounting rate assumed to be 10% across all years.

In this analysis, we will consider 20 students to carry out the cost benefit analysis. The table below estimates the costs and benefits amounts.

Type of cost Cost amount ($) Types of benefit Benefit amount ($)
Fixed costs Organizational benefits
Total fixed costs 4750 Sponsorship savings 1500
Variable costs Revenue from French classes 4500
(Total variable cost)*20 11,900 Competitive advantage 3500
Students benefits
(Saved costs French classes)*20 4000
(Saved hustling time)*20 2000
(Better understanding)*20 2000
Instructor benefits
Simplified teaching 1000
Total 16,650 18,500

Present value, future value and risk allowance

The estimated $ 18,500 is the valuation of cross multiple year benefits beginning one year after implementing the online system to learn French. The net present value of the benefits is $18,500(1+0.1)-1 = $16,818. The expected value of the benefits after 5 years is $16,818(1+0.1) ^5 = $ 27,085. However, there is provision for risk allowance of 0.01 in case of emergencies as fire, complete breakdown of machinery and theft that would distract the normal functioning of the online system to learn French.

Conclusion

From the analysis, it is evident that the benefits associated with putting up an online system to learn French outweighs the costs (Thompson, 2000). This is a clear indication that the school would save more on the expenses on sponsoring students and teachers to learn the French language if it were to establish the project. Furthermore, the school would generate revenue from the project with the students and instructors benefiting concurrently. The cost benefit ratio for every stakeholder is unquantifiable, but the cost benefit ratio for the entire organization it is 1.111 Therefore, the project of putting up an online system to learn French is worth investing.

References

Hubbard, W. (2010). How to measure anything finding the value of “intangibles” in business (2nd ed.). Hoboken, NJ: Wiley.

Juran, J.M., & Gryna F.M. (2003). Quality Planning and Analysis. New York: McGraw-Hill.

Kingma, R. (2001). The economics of information: A guide to economic and cost-benefit analysis for information professionals (2nd ed.), Englewood, CO: Libraries Unlimited.

Lacity, M.C., & Hirschheim, R. (2012). Implementing information systems outsourcing key issues and experiences of an early adopter. Journal of General Management, 19 (1), pp. 17-29.

Mishan, E. J. (2008). Cost-benefit analysis (4th ed.). London: Unwin Hyman.

Montgomery, D.C. (2002). Introduction to Statistical Quality Control. New York, NY: New York: John Wiley & Sons.

Ostrenga, M. (2005). The Ernst and Young Guide to Total Cost Management. New York, NY: John Wiley & Sons.

Thorsteinsson, P. B. (2010). On the classification and estimation of costs in information technology (M.Sc. thesis). Iceland: University of Iceland.

Thompson, M. S. (2000). Benefit-cost analysis for program evaluation. Beverly Hills: Sage.

Varian, R., Farrell, J., & Shapiro, C. (2004).The economics of information technology: An Introduction. Cambridge: Cambridge University Press.

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